A number now believe that interest rates have peaked, after working themselves into a frenzy merely weeks ago about how rates would keep rising.
We think it’s far too soon to get excited – all the commentators who are pointing to falling energy prices should bear in mind that oil is still loitering around the $60 a barrel mark – it might have fallen out of the headlines for now, but there’s still plenty of reason to believe it will be higher by the end of the year.
But in any case, a recent letter to one of the newspapers shows that interest rates are already high enough to be causing problems for the buy-to-let investor…
There was a fascinating piece on the thisismoney.co.uk website earlier this week, from an amateur landlord asking for advice. The individual wrote in about a buy-to-let property which they had bought three years previously with an interest-only mortgage of £230,000.
The property was now worth £320,000, but the fixed rate of 4.5% was about to run out – and the unfortunate landlord was just about to discover how much of an impact those recent interest rate rises are set to have on the finances of naïve property speculators.
“As my fixed rate has run out, I need to remortgage. However, rates have risen to make potential monthly payments the same as the rent.” Moreover, the landlord was dismayed to find that buy-to-let lenders are also now “charging big fees” or adding on early redemption charges “which outstrip the deal period”.
Now, there are some pretty tough questions in there. For a start, this person is out and out admitting that their rent will only just cover the mortgage – forget about void periods, maintenance or anything else.
That’s really not a great situation to be in – it leaves you utterly reliant on capital gains for profit, which once upon a time, not so long ago, was not the way that investors in property did things. The main argument for buying property used to be that it was a conservative asset class which provided a steady income stream – but a tidal wave of money has washed away any thoughts of fundamental value or investing sensibly, and nowhere more so than in the residential property market.
So you might think the landlord’s main question would be – how quickly can I sell, and what are the capital gains implications?
But no – the main thing on the writer’s mind was whether they would be able to get a mortgage or not. “Will the rent only just covering the mortgage be an issue? I have enough income from elsewhere to cover the mortgage if need be.”
We’ve pointed this out before, but let‘s do it again. If you bought shares in a company paying a nice dividend one year, and then the following year, it slashed the dividend to zero and said that you would in fact, have to start paying the company for the privilege of holding onto the shares, what would you do? You’d sell, of course.
In fact, the only situation under which you wouldn’t sell, is if the stock was in the grip of some rampant, irrational, speculative bubble whereby investors (including yourself) had come to believe that its price could only go up and up and up.
That’s probably along the lines of the reply we’d have given the landlord in question. Of course, we weren’t asked. So which neutral, independent financial adviser, with no vested interest in the state of the property market at all, was given the job of answering the query? Why, Lee Grandin, managing director of Landlord Mortgages, of course.
Mr Grandin’s response was reassuring: “It is always a cause for concern when a landlord struggles to meet the mortgage repayments with the rental income. However, you may take some comfort in the fact that you are not alone.”
This isn’t actually very comforting. If you are holding an investment which has suddenly become somewhat difficult to afford, it is far better if you are the only person affected. It’s much better to be the only one of 100 people who wants to sell an asset, because then you’ve got plenty of willing buyers. If, on the other hand, you and 98 other people want to sell, then the one person who wants to buy will get themselves a bargain.
Mr Grandin goes on to say that after interest rates rise, it can take years “for rental income to reflect the extra cost of living”. But it will eventually, “as long as we do not suffer a recession.” And of course, there’s the supply and demand argument – “the general lack of rental property in the UK will ensure that any slowdown is only short term so it is inevitable that rents will climb again.”
Can we just note at this point that if a fund manager said “it is inevitable that stocks will rise again” they would be flogged at dawn by the regulators? And we’re surprised there’s a lack of rental property – if that’s the case, then why haven’t rents shifted for so long? And how can there be a lack of rental property when every two-bedroom flat in the British Isles is being snapped up by amateur landlords?
He finishes by saying that “the lack of rental coverage may hinder your application, so I suggest you speak to a broker who will know which lenders are best for your situation.”
The reason that lack of rental coverage is a hindrance is because most lenders know that if you’re not getting enough rent to cover the mortgage then your ‘investment’ is not a sustainable one, and it increases the chances of them having to shut you down at some point in the future.
The kind of mortgage brokers who will take on clients like this, are the ones who then parcel up the loans to sell on to the likes of hedge funds. The kind of mortgage brokers who are now running into serious trouble in the US (we wrote about this earlier this week – for more, see: Will the US sub-prime mortgage meltdown spread? ))
We reckon it won’t be long before some of the other landlords in this position decide it’s not worth forking out a couple of grand a year from the hard-earned salary provided by their day jobs to subsidise their ‘bricks and mortar pension funds‘.
And when they start to sell, the others who are in it for the “long term” might soon change their minds when they see their capital start to shrink. Our advice? If you are having to pay your tenant’s rent, find another home for your money.
Turning to the stock markets…
In London, the FTSE 100 closed 28 points higher, at 6,381, as the mining sector rallied. Miners Antofagasta, BHP Billiton and Rio Tinto topped the FTSE leaderboard, whilst British Land was the day’s biggest faller following its cautious comments on the outlook for the UK property market. For a full market report, see: London market close
Across the Channel, the Frankfurt DAX-30 closed at 6,895 yesterday, a 35-point gain.
On Wall Street, US stocks closed sharply higher. The Dow Jones gained 102 points on news that component Alcoa may be the target of a takeover bid, ending the day at 12,654. The tech-heavy Nasdaq closed at 2,459, a 9-point gain. And the S&P 500 closed 10 points higher, at 1,444.
The Nikkei closed higher for the fourth day in a row on the back of the weaker Yen, ending the day 131 points firmer at 17,753.
Crude oil last traded at $58.94 in New York and Brent spot was 17c lower – at $56.68 – in London.
Spot gold hit an intra-day high of $688.35 in Asia trading, but had fallen back down to $667.80 today.
And in London this morning, shares in heating equipment supplier Wolseley experienced their biggest rise in four years following news in City AM this morning that private equity firm Cinven may make a bid for the company. Wolseley’s share price had risen by as much as 8.2% today.
And our two recommended articles for today…
Three reasons to invest in India
– Economist Stephen Roach recently returned from a trip to India persuaded that the country could be one of the world’s ‘most exceptional economic stories’ of the next few years. Here he identifies the three key economic trends giving rise to his optimism: Three reasons for invest in India
Where next for the gold price?
– It has been more than a month since what looks like a selling climax for gold. Both silver and the yellow metal are making impressive progress – but can the good times continue? To find out what the charts are telling us, see: Where next for the gold price?